Brazil: Stalking Horse Bidders Under Court-Supervised Reorganization In Brazil

Due to the increased requests for Court-Supervised Reorganization, especially those involving multinational companies (OGX, OSX, Parmalat, etc.) there is an escalating search for new mechanisms that enable a more effective recovery of credits and reorganization of financially-distressed companies.

One of the frequently discussed and addressed elements in court-supervised reorganization plans is the so-called sale under Article 60.

Law no. 11101 of 2005 (Law on Corporate Reorganization and Bankruptcy - "LRF"), regulates the required conditions whereby the disposition of the debtor's assets will benefit from the purchaser not inheriting said debtor's debt and liabilities (including labor and tax liabilities); this benefit makes purchases of assets by potential investors more attractive.

As to disposition of assets, generally speaking, although the debtor is free to continue to manage and maintain its business, it loses the right to "dispose of, or encumber, items or rights from its permanent assets" (Art. 66), except in case of court authorization after hearing the creditors' committee, if convened. Such "ad-hoc" authorization is waived in case the assets are previously listed in the court-supervised reorganization plan.

For the disposition of assets not to result in the succession of the labor, tax and other liabilities of the debtor company, it must, in accordance with Article 60 of LRF, involve a set of assets and rights economically organized, such as a plant and its employees and clients, a business establishment, or a service provision office. The law identifies this type of business unit as an "Isolated Production Unit", or UPI, in the Portuguese Acronym.

Only the court-ordered sale of a UPI has the powers to rule out the succession effects, pursuant to Articles 60 and 141 of the LRF. The law establishes three methods for court-ordered dispositions: auction, sealed bids or a third type ("pregão"), which is a mix of the auction and the sealed bid ("mixed bid").

The disposition, under whichever method, must be based on the proposal with the highest value. However, it is important to stress that in case there are justified reasons and upon a well grounded request from the trustee or the Committee, the judge may authorize a court-ordered disposition different from those under Art. 142 of LRF (Art. 144).

Another noteworthy issue is the expectation that the judge will ratify any other type of asset realization, so long as it is approved by the general meeting of creditors (Art. 145).

The U.S., which has constantly modernized its regulation of the reorganization and bankruptcy, has developed an interesting mechanism concerning asset disposition: the Stalking Horse.

Stalking Horses are third parties which may or may not be creditors and which make a certain and proposal to acquire a certain asset from the debtor, thus establishing a floor price for proposals to purchase that asset in a bid-like procedure. At this point, a Stalking Horse is given preference in the purchase of the asset, but potential purchasers may offer higher amounts than the one initially proposed by the Stalking Horse. In this event, the Stalking Horse may either outbid the offer or give up the purchase of the asset. "Theoretically, a "Stalking Horse Deal" is an attempt by the debtor to test the market prior to an auction or reverse auction. The intent is to maximize the value of its assets as part of (or before) a court auction in case of bankruptcy." The debtor may offer bidding protections, such as breakup fees for its best bidder prior to the auction or reverse auction. These incentives increase the value of the offering for the bidder, which may lead to a better offer before the auction begins. This higher bid then becomes the starting bid for the auction.

A Stalking Horse interested in the purchase of assets in a Brazilian Court-Supervised Reorganization is not only beneficial to the debtor, which will have a certain and undisputable proposal to sell its assets, but, furthermore, does not prevent or hinder, in any way, other interested creditors from making bids, which supports the underlying general principle of a court-ordered sale, namely to assure the transparency and the best price.

Lastly, Article 144 grants the judge a considerable leeway to introduce changes in the types of court-ordered sales under Article 142, and a third party acting in a manner identical or similar to a Stalking Horse, which is transparent and benefits the best bid, does not violate the principles that inspired such article.

Furthermore, Article 142 clarifies the mixed-bid and thus created an unintentional parallel with the Stalking Horse institute, as it is precisely the submission of sealed bids for selection of the best bid that determines the floor price of the open outcry auction, provided that the highest bidder attends the auction and confirms its proposal.

The only difference from the auction under Article 142, which may be applicable in view of the provision in Article 144, not diverting, however, from the underlying principles that inspired Article 142, is the setting up of the floor price for the auction, as negotiated between the Stalking Horse and the debtor.

The participation of a strong Stalking Horse investor is very relevant in cases, where the object of the sale is surrounded by contractual complexities, such as those caused by a UPI in operation, or regulatory issues (regulated activities, public utility companies, sensitive and confidential technology, etc...). In these cases the preparation of a serious and structured proposal will only be possible upon a due diligence and preliminary negotiations conducted out of court. This is typically the function of the Stalking Horse. Usually, the Stalking Horse is a large investor, an investment bank or a strategic partner with a renowned technical and financial capability, therefore tracing a straighter path for the court-ordered sale itself.

The Stalking Horse may, depending on its interest in the purchase, fund the required studies and analyses needed to outline the due diligence and the proposal, and, in cases where debtor faces more severe financial distress, even offer a bridge loan until the court-ordered sale is made.

These amounts could even be provided for as part of the purchase price, either upon an offset in case the Stalking Horse wins the open auction, or upon a direct payment to the Stalking Horse, made by the winning purchaser, in case the Stalking Horse loses the bid.

In conclusion: as the core purpose of the Court-Supervised Reorganization is to promote the debtor's turnaround and, in regard to the disposition of assets, defend the highest bid (which would be ensured by the way the Stalking Horse operates) and the full participation of creditors and any interested third parties, we do not envisage any legal impediment to the disposition of UPIs without succession, involving the so-called "stalking horse deals", as such structures not only give more certainty to the UPI sale procedure, but are within the judge's discretionary powers, pursuant to Article 144 of the LRF.

The 'Stalking Horse' in a US Chapter 11 363 Sale From Financier Worldwide's May 2006 Edition

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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